A few weeks ago, we wrote about how debt oriented mutual funds are more tax-efficient than bank fixed deposits. The other day a friend told that fixed deposit rates are falling every day. Indeed, with bank fixed-deposit rate hovering around 6.5%, post-tax return of fixed deposit or interest on saving account balances is quite low, especially for people in the higher tax bracket. Equity arbitrage funds are good ta-efficient substitute for money lying idle in a bank account that is earning 3-4% on pre-tax basis.
What are equity arbitrage funds?
Whenever price of one thing differs at different places then there is potential to make a risk-free profit. One can buy at the place where the stuff is available at cheaper price and simultaneously sell where it can be sold at higher price. In the process, one can make a risk-free profit by exploiting the price arbitrage. Now, in stock market there is difference in the price of a stock/ index and the price of futures on the same stock/ index. Fund managers with skill in this field are able to monetize the arbitrage between the prices of the two instruments. Equity mutual funds that exploit such price anomalies are called equity arbitrage fund.
What type of return to expect from arbitrage fund?
Historically, the difference in price is determined by dividend yield and the interest rate. Without getting too technical, the return in past has been around 6-7%. With fall in interest rate, the return could fall a bit and may remain around 6%, on average.
How long it takes to get my money back after selling the arbitrage funds?
The redemption proceeds will be transferred into your bank account in three working days from the date of placing the sell order (if sell order placed before 3PM).
How the equity arbitrage funds are taxed?
One of the main attraction is tax-efficiency of arbitrage funds. From taxation perspective, Equity arbitrage funds are treated at equity funds. Hence, if sold in less than 1 year, the tax rate is 15%. If held for more than 1 year, the equity arbitrage fund return is completely tax-free. Dividends are tax-free.
How safe are arbitrage funds?
When I looked at performance of an average arbitrage fund, lowest one year return was around 2.4 %. So, for a holding period of around a year, negative return is highly unlikely. As arbitrage funds look to exploit just price anomaly and not make a directional call on market, they are relatively safe.
Is all the hassle worthwhile?
Instead of going through all this hassle, isn’t it better to just open an account with Kotak or Yes bank and get 6% return. Now, the interest income on saving bank account (above 10000 rs across all bank accounts) is taxed at applicable slab rate. Clearly, equity-arbitrage funds are tax-efficient. Now buying and selling mutual funds is no longer a big hassle and in fact is easier than opening bank account. Furthermore, banks have different rates on saving account and that depends on how much balance you maintain. Also, if your prime banking relationship is with banks like HDFC Bank, ICICI Bank or SBI, it is really not worth it to open a new bank account just for this purpose. Contact your financial advisor who can guide you on investing in arbitrage funds.
Finally, arbitrage funds are a good option for investors looking for tax-efficient substitute for idle money kept in saving bank accounts or for small businesses who are keeping money in current accounts. If you have lump sum amount, you can invest in an arbitrage fund and do a systematic transfer to a balanced or diversified equity funds.
Disclaimer: The above content is just for information and should not be construed as an offer to buy or sell or recommendation. Contact your financial advisor for guidance on any investment related query.
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